Sunday, September 21, 2014

A thought for Sunday: the boring devil of an economy you know

- by New Deal democrat

I have always wanted to give readers "value added" -- not just report on the data like you can read at 100 different sites, or expound on a worldview with (intentionally or unintentionally) cherry-picked data. I think I'm pretty good at the economic version of what Wayne Gretsky famously called "skating to where the puck will be," and presumably you do too or you wouldn't be reading me! Since it's Sunday so I can kick off my shoes and pontificate without having to document everything with data. I thought I'd update my view of the bigger picture, since it is something I haven't done in awhile,

1. There is no political will to do anything to assist the economy, e.g., infrastructure repairs and upgrades, assistance to the middle/working classes. Back in 2009, Bonddad and I jointly called for the creation of a new WPA to help ameliorate the worst unemployment situation in 75 years. It become pretty clear by 2010 that none of the things an activist government might have done were going to happen, beyond the 2009 stimulus. I haven't seen the point in arguing in favor of any progressive economic agenda items that not only aren't going to happen before 2016, they almost certainly aren't going to happen before 2020 as things stand now.

The best we can hope for in the foreseeable future is that Washington does no further damage to the average American's well being, with further spasms of austerity (e.g., cutting off extended jobless benefits) or downright recklessness (threatening to refuse to pay the US's bills).

2. Since Washington isn't going to be of any assistance, this is the economy we have. It has been, is now, and is probably going to continue to grow at 2% or so, give or take. Jobs will probably continue to grow by about 200,000 a month, with the occasional upside or downside outliers. The various unemployment rates will probably continue to slowly decrease. Real wages will continue to be flat to slowly rising.

The slow growth is the result of a number of factors: the global race to the bottom, the ever-increasing concentration of wealth, continuing advances in automation, the secular increase in the price of Oil, and an aging population not only in the US but throughout the developed world (older folks don't buy nearly as much new stuff as younger folks who are making a new home and raising children).

The slow growth we've experienced since 2009 isn't going to change for the better in the immediate future. On the other hand, there is no sign that it is about to change for the worse.

3. While we are probably past the middle of the cycle, this is hardly shocking 5 years after the economy started to improve. The typical spending patterns I would expect to see as the cycle wears on have happened - e.g., a slow decline in real consumer spending, and a general plateauing in the purchase of vehicles. But that doesn't mean The End is Near. In fact, one of the noteworthy things I've noticed in the last few months is the virtual disappearance of Doomer commentary. It's so bad I actually have to go over and read Zero Hedge to make sure it still exists.

So let me tell you what I think reasonably could change the present dynamic for better or worse in the near future.

4. What would make the economy come closer to "escape velocity?" Is there anything that is reasonably likely to happen that could give the economy a second wind? I see two candidates:

Even lower long term interest rates (refinancing, home purchasing). Long term treasuries bottomed at 1.74% in mid 2012. Mortgage rates made a bottom just over 3% shortly thereafter. Corporate bonds yields also made lows in 2012. Recently corporate bonds in particular have come near those lows. A new low in bond yields would send a powerful signal that the expansion is going to continue for awhile, especially with the inevitable new round of refinancing of consumer debt at lower rates.

Gas prices declining under $3/gallon. Gas prices are like a tax on consumption. The less consumers spend on gas, the more they can both save and spend on other stuff.

A significant rise in median real wages. This would be nice. I just don't see it in the near future (except as a byproduct of a further fall in gas prices). Hence, not a third candidate.

5. On the other hand, what are the most likely trends that would cause an economic downturn?

Well, first of all, the reverse of the two items I listed above. Higher interest rates would bite into consumption, as would higher gas prices.

"Conundrum 2." If the Fed actually starts raising short term rates while long term rates are declining, that would create one of the classic signs of a recession coming - i.e., a flat to inverted yield curve. If it happens in a deflationary environment, that would be even worse. Such a yield curve has only happened twice in the last 90 years -- in 1928 and 2006. That's why I call it the "Death Star."

The combination of no increase in wages, no new lows in long term interest rates so no refinancing, together with a significant downturn in stock prices lasting several quarters. This is the most likely scenario. By next summer, we will have gone 3 years without consumers having been able to refinance debt at lower interest rates. Since 1981, this has been the sine qua non for a downturn. When the inability to refinance is accompanied by no wage increase, and no increase to new highs in widely held assets, in each case a recession has followed.

At the moment, house prices are still increasing, but not nearly to new highs, and there is very little home equity withdrawal going on, so that is not a source of consumer funds. On the other hand, stocks have been making new highs all this year. This appears to be having a pronounced wealth effect among the affluent to wealthy households that own stocks, and is fueling consumption (although none of that is "trickling down" to the bottom tiers).

In conclusion, unitl one of the above scenarios finally tips the balance, growth will wax and wane. I still think there will be deceleration in the remaining part of this year. An uptick in the first part of next year looks more likely than a continued deceleration.